Why China shouldn't wait out trade feud with U.S.A

A common refrain from some long-term China observers is that the government in Beijing can just wait out a significantly more confrontational U.S. trade policy now that the initial shock is past.

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After all, the uncontested Asian powerhouse is on track to be the largest economy in the world.

It also has a long tradition of government that shrewdly takes a long-term perspective to continuously deliver growth, opportunities and prosperity to its citizens. But there’s an important nuance this time. Unless China's traditional long-term strategic stance is combined with a seemingly contradictory short-term tactical approach, the country could risk major damage to its development and prospects for prosperity.

China is one of the few countries to have a relatively long succession of leaders able and willing to repeatedly combine three policy methods that are central to development sustainability:

- Setting out an overriding long-term objective that serves as a North Star for the many segments of society;

- Taking concrete steps toward that goal even though policy makers may be confident only about the initial set of implementation measures rather than the whole path (or most of it);

- And being open to an intense learning process, quickly and effectively internalizing lessons that allow for the timely execution of course corrections.

This approach has been key not only to sustaining a historically impressive, if not unprecedented, development process but has also allowed China to navigate a broad range of unanticipated shocks that derailed other emerging economies. And this process is set to continue with the consolidation of power under President Xi Jinping.

Indeed, it’s a major reason why some Chinese observers feel that the best strategy is simply to wait out President Donald Trump’s administration -- that is, to continue to resist U.S. pressures by making no concessions on trade, maintaining the tariff tit-for-tat and holding out for better relations in future.

Some go even further, noting that China could counter U.S. sanctions by threatening to dump its huge holdings of U.S. Treasuries.

They argue that this has become a more feasible option for China, given both its growth and the extent to which it has built small pipes around the U.S.-dominated core of the international monetary system (through regional arrangements, such as the One Belt, One Road initiative, bilateral payments agreements and alternative institutions such as the Asian Infrastructure Investment Bank).

There are also those who argue that China wouldn't be able to compromise even if it wanted to because the government needs to “save face” at home and/or because the Trump administration does not yet know what it wants in terms of concessions.

There are several problems with these arguments. For example:

The pressure on China is likely to increase rather than stay constant, and the next step may involve not just more protectionist steps by the U.S. but also a more unified approach to China from traditional American allies (especially in Europe and North America).

China risks losing more than the U.S. from intensifying trade tensions, as has already become clear from partial economic and market indicators.

The threat to dump Treasuries is not credible as there are other assets that can serve as a widely acceptable store of value for China’s international reserve holdings.

Defusing the tensions will become a lot harder as the political debate in the U.S. shifts from viewing trade as simply an issue of unfair practices by China to seeing it as a question of national security.

These problems could derail China’s development process by increasing the risk the country could get stuck in what economists call “the middle-income development trap,” which has frustrated many other emerging economies.

Rather than wait it out, China would be better advised to follow the approach of South Korea, Mexico and Canada by making concessions to reach an accommodation with the US. Xi could use the G-20 meetings in Argentina next month to offer concessions to Trump centered on three issues: relaxation of joint-venture requirements and other restrictions that limit foreign companies’ operational freedom and force technology transfers; a verifiable effort by China to counter intellectual property theft; and time-specific agreements on energy and foodstuff imports that would reduce the bilateral trade surplus vis-a-vis the U.S.

Those steps would offer a viable possibility for defusing trade tensions, giving China more time to continue to gradually reduce its co-dependency with the U.S. (which it shows every intent of doing regardless of the state of trade relations between the two countries) and strengthen its domestic drivers of growth (now one of the main objectives of China's long-term strategy).

Making concessions now won't deliver China’s theoretical “first best,” nor will it be free of costs and risks. Yet it may well be the best feasible option the government has if it is to avoid the bigger threat of seeing its development process derailed.